Hub and Spoke Structure – What it Means in Portfolio Management

What is a Hub and Spoke Structure?

The hub and spoke structure, also known as “master-feeder” structure, is commonly used by investment firms such as asset managers and hedge funds to pool assets together, cut costs and improve efficiency. In the hub and spoke model, there are typically a number of investment vehicles that have the same objective. The main fund, which serves as the “hub” (or “master” fund) is the central investment vehicle that holds the main assets and performs the core investment management activities. The smaller funds that feed into the main fund are the “spokes” (or “feeder” funds). They may have different fee structure, distribution channels or investor types but still rely on the same core investments managed by the “hub”.

How it Works?

A hub and spoke structure is often used when a strategy is marketed across various regulatory jurisdictions. Both the feeder and master funds will accept subscriptions (new money into the fund) and redemptions, but the feeder will invest all the proceeds in the master. Meanwhile, investment decisions are made by the portfolio managers at master-fund level. Feeder funds are separate legal entities and may therefore show a difference in investor types, fees, minimum investment amounts, and the Net Asset Value (NAV).

Hub and Spoke Model Diagram

Below is an illustration that shows how the structure works and how it compares to other fund structures.

Source: The Financial Conduct Authority (FCA),

A key feature of the master–feeder funds is that they all use the same investment strategy (and benefit from economies of scale), unlike the “Umbrella” fund structure where the sub-funds can offer different investment strategy.

Example of a Hub and Spoke Fund

Many asset managers are using this type of structure in their offerings, one of them is Fidelity. For example, their Fidelity Alternative Listed Equity Feeder Fund (the “spoke”) invests at least 95% of its net assets in the Fidelity Alternative Listed Equity Fund (the “hub”) and would maintain up to 5% of the fund in cash and liquid instruments for liquidity purposes.

Another example of a master-feeder structure is the BlackRock’s Money Market Master Portfolio, which is the mater fund for the BlackRock Cash Funds: Institutional (the feeder fund).

It is also important to differentiate the hub and spoke structure from that of the fund of funds. In hub and spoke, the master fund makes direct investments in various securities, while a fund of funds invests in a number of strategies but has no say in their investment decision making or strategy. Some of the key differences are outlined below.

Hub and Spoke Model Advantages and Disadvantages

Hub and Spoke Model Advantages

There are various advantages of the hub and spoke but some of the key ones include:

• Economies of scale – investors can benefit from improved operational efficiency and reduced transaction costs. For example, the portfolio manager of the master fund does not need to undertake additional research for holdings that are not held in the main fund. It also eases the administrative burden of maintaining multiple portfolios
• Reduced trading costs – as the master fund pools large amount of capital from various investors, trade execution can be done as a single trade. This will optimise trading fees
• Tax benefits – since all transaction fees and expenses are paid from the master fund its structure allows each feeder fund to be operated individually with its own rules (but not in terms of managing the investments in it, which is done at the master level). For example, offshore vehicles may have different tax regime on income and capital gains, but the master-feeder structure would allow US-based investors to remain invested without being affected through a feeder fund

Hub and Spoke Model Disadvantages

However, there are some important drawbacks to flag as well:

• Complicated accounting and tax rules – offshore funds are generally subject to 30% withholding tax on US dividends. In addition, some investment types, such as REITs can be appropriate for US investors, but inappropriate for offshore investors due to various regional restrictions
• “One size fits all” – setting up a universal investment strategy is quite challenging when assets are pooled from various investors across multiple geographies. Therefore, it is key that the objectives and risks associated with the fund are communicated clearly

Typical Hub and Spoke Structure of a Fund with Onshore and Offshore Feeders

Access the free download the Hub and Spoke Structure of a PE Fund for a full breakdown

Conclusion

To sum up, the hub and spoke structure is an effective mechanism to pool assets together from various investor types and regulatory regimes into one investment strategy. While the underlying investors may be charged different fees (primarily as a result of their geography, investor type and local regulatory environment), they are all given exposure to the same fund and benefit from the economies of scale, achieved through the pooling of assets. Along with benefits such as reduced trading costs, investors should however be aware that accounting and tax can be complicated under this structure.